Rental property deductions have many rules, and the ATO is on the lookout for incorrect claims. Some expenses can be deducted immediately, while others will need to be claimed over time. Stay on top of the rules and avoid ATO headaches this tax time.
Did you know that a random audit by the ATO last year revealed nine out of ten rental property owners made a mistake with their rental deductions? We share some tips on what you can and can't claim.
This article assumes you own a 100% rental property (with no private use) that is rented out, or genuinely available to rent, at commercial rates. You'll generally only be able to claim a portion of your expenses if:
- you have a dual-use holiday home;
- you sometimes rent out your home on Airbnb;
- your property is leased at "mates' rates" to friends and family; or
- your property is sometimes not available for rent.
Buying an investment property carries a host of upfront expenses, but not all of these are deductible straight away.
Stamp duty is not deductible, and neither are conveyancing or legal fees for the purchase.
Instead, these expenses will be included in the asset's "cost base" for capital gains tax (CGT) purposes when you later sell the property, which effectively reduces the size of your capital gain.
On the other hand, ongoing land tax (and other charges like council and water rates) are deductible. Legal fees you incur later may also be deductible if they relate to things like evicting a tenant or suing for loss of rental income.
Another trap that can arise is initial repairs. If you need to remedy damage that already existed when you bought the property, the repair costs are not immediately deductible in the year you incur them. Instead, these can be claimed gradually over time as capital works deductions (or sometimes as depreciating assets).
You also can't deduct costs associated with selling the property, like advertising and conveyancing expenses (which instead form part of the asset's CGT cost base). You can, however, claim advertising costs for finding tenants while you own the property.
Repairs or improvements?
While initial repairs aren't immediately deductible, ongoing repairs and maintenance costs for damage and wear that arises while the property is leased (or available for lease) are deductible in the year you incur them. This includes costs not only to remedy direct damage or deterioration, but also for preventative maintenance to keep the property tenantable, such as oiling a deck. Gardening, lawn-mowing, cleaning and pest control are also deductible.
It's vital to distinguish between a repair and an improvement. This is because unlike ongoing repairs, improvement costs are not immediately deductible. The ATO says that if the work doesn't relate directly to wear and tear (or other damage) from leasing the property, it's not a repair. Examples of work that isn't a "repair" but more likely an improvement include:
- Replacing an entire structure when only part of it is damaged.
- Replacing a damaged item with something that's better and changes its character (eg replacing a broken plaster wall with a brick feature wall).
- Renovations or additions to make the property more desirable or valuable.
Some improvement costs are claimed over time as capital works deductions (where they are structural improvements) and in other cases as capital allowances (where they involve a depreciating asset such as carpets, timber flooring and curtains). Note that new rules from 2017 restrict deductions for depreciating assets already used in second-hand residential investment properties at the time of purchase. Your tax adviser can help you navigate these and other complex rules about capital deductions.
Are you paying off a loan for an investment property you've purchased? The ATO says over-claimed interest is a common error made in rental property expense claims. Find out when you can deduct your interest payments and other associated loan costs, and stay on top of the rules this tax time.
The general rule is that you can deduct interest expenses on a loan you've taken out to buy the property to the extent the property is used for generating rental income. You can generally deduct these interest expenses in the year you incur them.
You can also deduct interest expenses on loans to fund repairs and renovations, or to purchase depreciating assets (eg an air conditioner).
But beware: traps arise when you start mixing private uses with income-producing uses. This occurs if:
- you use the property for private purposes – even to a small extent – in addition to renting it out; and/or
- you use part of the loan for private purposes (eg to buy a car or pay for personal living expenses). This includes where you're ahead on your loan repayments and redraw available amounts to fund private expenses.
In these cases, you'll only be able to claim a portion of your interest expenses. You'll need to keep records to substantiate what portion is private and what portion is rental property-related.
When you make a loan repayment, the ATO considers it to be apportioned across both private and rental purposes. (That is, you can't "cherry-pick" by earmarking some repayments as related to the "private" part of the loan and others as "rental"-related.)
It's important your claim stacks up because the ATO says over-claimed interest is on its hit list of common mistakes it's watching for this tax time. The ATO is also concerned about holiday rentals that aren't genuinely available for rent, and properties that are leased out at "mates' rates" to friends and family.
Are you claiming the full range of loan costs you're entitled to? You can deduct costs like loan establishment fees, mortgage brokerage fees and costs of other necessary services that are directly related to taking out the loan for the rental property (such as title searches and property valuations required by the lender).
In some cases, you'll need to carefully distinguish between costs of taking out the loan, and costs of buying the property:
- Legal services of preparing and lodging mortgage documents are deductible as loan costs, but conveyancing fees for purchasing the property are not.
- Similarly, any stamp duty on a registered mortgage is deductible, but stamp duty on the purchase of the property is not.
While you can't claim any premiums for insurance you take out to pay out the loan in the event of your death, disablement or unemployment, you can deduct any lender's mortgage insurance that is billed to you by the lender.
Watch out for special timing issues. Unless your total deductible loan costs are below $100, you'll need to claim these costs over five years (or the term of the loan, whichever is the shorter period). And as with interest expenses, you can only deduct a portion of your loan costs if the loan will also be used partly for private purposes. Your tax agent can help you calculate the exact amount to deduct each year.
We'll help you get it right
Whether you're planning finance for a new investment property or already paying off an existing loan, talk to us for expert assistance in planning tax-effective rental property investments and getting your annual deductions right.
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